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U.S. Avoids Default in 2011 and 2013


What would happen if the U.S. defaults? That's the $14 trillion question.

 

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In early August 2011, Congress and President Obama made a last-minute deal to avoid a default on the U.S. debt, but as the deadline to raise the debt ceiling approached, many people wondered what would happen if the government failed to reach an agreement. Some believed a default would send the global economy spiraling, while others said the consequences would be insignificant.

If the U.S. government didn't make a deal to raise the debt ceiling by August 2, 2011, credit rating agencies, such as Moody's and Standard & Poor's, warned that they would downgrade the country's current AAA-rating. Treasury bonds and other asset classes would have felt the impact of a downgrade. Around $130 billion in municipal bonds would have been downgraded and all other bonds would have come under review. The financial sector, which had previously assumed that the government could bail out major banks if they ran into trouble, would not have that safety net if the government was broke. A default would also have put a strain on the U.S. and its creditors. In Treasury bonds, U.S. dollars account for a large percentage of global bank reserves. For example, China holds about $1 trillion in U.S. Treasury bonds. The value of China's holdings would have decreased if the U.S. defaulted.

Never Been Here Before

The biggest issue with the default was the uncertainty. No one knew for sure just how much it would affect the already shaky U.S. economy or the global market, mainly because the U.S. hadn't been in the situation before. Some economists argue that the U.S. has defaulted twice on its debt: in 1790, when the federal government restructured bonds issued to fund the Revolutionary War; and in 1933, when Congress passed a bill making it illegal for creditors to demand payment in physical gold. However, even though both incidents were technically defaults, the creditors involved were paid. Therefore neither situation could shed much light on the possible U.S. default in August 2011.

Late in the evening of July 31, 2011, President Obama and Congressional leaders reached an agreement that would raise the debt ceiling by $2.4 trillion in two stages. They also agreed that $2.4 trillion in spending cuts would be made over the next decade and $900 billion in cuts would be made immediately. The House approved the plan on August 1st. The Senate approved it on the following day. A default was narrowly avoided. A bipartisan Congressional supercommittee was appointed and given until Thanksgiving to find $1.2 trillion in deficit reductions.

Supercommittee Fails

In November 2011, the Congressional supercommittee failed to agree on what programs to cut after more than 10 weeks of negotiations. Therefore, $1.2 trillion will automatically be cut from military spending, education, transportation, and Medicare. The committee's failure also set the stage for Congress to spend the next year battling over which programs would receive deeper cuts.

Throughout 2011, states also struggled with the stalled economy. Minnesota Democrats and Republicans failed to agree on a solution for the state's budget problems, and the government shut down over the summer. State employees were sent home without pay. Parks, historical sites, the Minnesota Zoo, and all major rest areas along highways were among the many state services closed. In November, Alabama's most populous county, Jefferson, filed the largest municipal bankruptcy in U.S. history. Jefferson County was over $4 billion in debt.

By December 2011, the federal unemployment rate decreased to 8.6%, its lowest level in two and a half years. While the debt crisis in Europe grew worse in the last days of 2011, the U.S. economy appeared to be on the mend.

The Song Remains the Same in 2013

However, even with a steadier economy, the U.S. Government found itself facing another default in the fall of 2013. On October 1, 2013, Congress failed to agree on a budget and pass a spending bill, causing the government to shut down. The failure to pass a bill was largely due to a standoff over the Affordable Care Act, also known as Obamacare. Already feeling pressure from the partial shutdown, Congress began tense negotiations in an effort to pass a budget by the debt ceiling deadline on October 17, 2013.

Some Americans felt the impact of the 2013 shutdown more than others. The partial shutdown meant that unemployment, social security and Medicare benefits would not be interrupted. The mail service would continue. Federal air traffic controllers and airport security screeners would still report to work. However, all national parks and Smithsonian museums closed. People seeking government backed mortgages and loans could experience delays. Active military personnel, about 1.4 million people, would stay on duty, but their paychecks would be delayed. Health and safety inspectors would stop workplace inspections except in emergency situations. Overall, the government shutdown forced about 800,000 federal workers off the job.

History Repeating Itself

As the October 17 debt ceiling deadline approached, the shutdown continued while Congress scrambled to find an 11-hour fiscal deal. Much like the situation in 2011, Congress came through at the last minute. On October 16, 2013, the night before the debt ceiling deadline, both the House and Senate approved a bill to fund the government until January 15, 2014, and raise the debt limit through February 7, 2014. The last minute bill avoided a default and ended the 16-day government shutdown. It also ended the Republican standoff with President Obama over the Affordable Care Act.

With a new federal budget needed by early 2014, the stage was set for another Congressional standoff and possible default in just a few weeks. Hoping to avoid that, Obama spoke shortly after the Senate passed the latest bill. He urged Congress to move ahead to the next budget negotiation, "We've got to get out of the habit of governing by crisis. We could get all these things done even this year, if everybody comes together in a spirit of, how are we going to move this country forward and put the last three weeks behind us?"


by Jennie Wood

Economics


Information Please® Database, © 2007 Pearson Education, Inc. All rights reserved.

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